Edited version of private advice

Authorisation Number: 1051611640071

Date of advice: 11 December 2019

Ruling

Subject: Compensation and capital gains tax

Question 1

Will the amounts received for the easement reduce the cost base of the land for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997?

Answer

No

Question 2

Will the amounts received for the easement be treated as capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening?

Answer

Yes

Question 3

Will the amount received for the permanent damage be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 4

Will the amount received for the permanent damage reduce the cost base of the property under section 110-40 or section 110-45 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Years ended 30 June 2019 to 30 June 2021

The scheme commences on:

1 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You own two properties, A and B (the properties). The properties were purchased post 20 September 1985 and are used in a business.

You have entered into an Agreement (the agreement) with ABC Pty Ltd (ABC) for each property.

You have agreed to grant ABC an easement to construct, operate and maintain the activity on the terms set out in each agreement.

You will receive compensation in respect of the grant of the Easement and the activities undertaken relating to the pipeline.

In relation to the properties, you have received payment for the following components:

·        $X easement

·        $X permanent damage

You have received payments to compensate you for the permanent damage caused to the land where it is likely to be permanently damaged due to soil erosion, mixed top soil preventing vegetation to regrow, additional weeds introduced and additionally the long term effect of noise, dust and restricted access of use of the land

On completion of the activities, ABC will, as soon as is reasonably practicable and subject to any agreement with you, rehabilitate the easement, affected surrounding areas and access route to it, to a standard similar to that which existed prior to the commencement of the activities in accordance with its obligations under the relevant laws.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Section 110-40 and

Income Tax Assessment Act 1997 Section 110-45.

Reasons for decision

Easement

Taxation Ruling TR 95/35 provides the ATO view in relation to the treatment of compensation receipts. Paragraph 6 states that:

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

For the purposes of TR 95/35 it is necessary to identify the underlying asset. TR 95/35 defines an underlying asset at paragraph 3:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

Paragraph 4 of TR 95/35 provides that if an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset.

In this instance it is noted ABC has the power to call on the state to grant it compulsory acquisition powers under the section 125 of the State Development and Public Works Organisation Act 1971.

Taxation Ruling TR 97/3 provides:

9. The acquisition of an easement by a public authority using the compulsory process provided in the relevant statute culminates in a declaration by notice in the Gazette that the easement has been acquired. However, it is possible that a public authority may acquire an easement by agreement with the landowner. One of the features which the various statutes have in common is encouragement of acquisition by agreement.

10. Because the easement is created in these circumstances by grant by the landowner there is scope for an argument that subsection 160M(6) applies. However, because the grantee of the easement (the public authority) has available, if it chooses to exercise it, the power to compulsorily acquire the easement, the amount received, in our view, takes on the same character as compensation for a compulsorily acquired easement. It is therefore appropriate that Part IIIA apply in the same way, that is, the consideration (compensation) is paid in respect of the part disposal of the land and not in respect of the grant of the easement.

It follows from the above that the receipts will be treated as compensation for the part disposal of the underlying asset being the land. Consequently CGT event A1 has occurred, there has been a disposal of a CGT asset namely rights held over the land for example the right of exclusion.

As there has been a compulsory acquisition no new asset has been created with the granting of the easement, rather rights relating to the land of have been disposed of. These rights have been held for longer than 12 months so you will be eligible to the general discount under division 115 of the ITAA 1997.

Permanent damage

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are 'statutory income'. Statutory income may arise from CGT events as consequence of an eligible claimant being entitled to receive compensation for the loss and destruction of a CGT asset.

Taxation Ruling TR 95/35 provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not consideration for the disposal of any other asset, such as the right to seek compensation.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to an underlying asset of the taxpayer or for a permanent reduction in the value of an underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset regardless of whether the compensation is received as one lump-sum or a smaller lump-sum and a series of annual payments.

Accordingly, the total acquisition costs of the asset should be reduced by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. If the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the underlying asset, there are no CGT consequences in respect of the excess compensation amount.

The activities undertaken by ABC will result in permanent damage to, or a permanent reduction in the value of the land.

As you did not dispose of all or part of the affected land there are no CGT consequences at the time of entering into the agreement or receiving the compensation payments. The land's acquisition cost will be reduced by the compensation payments received in relation to that land.